Did you know that placing a stop loss order with your broker in the market when they’re trading could be ruining your trading profitability?
Let’s say we entered the trade on this candle, and we placed our stop-loss. The trades going along fine, and our stop-loss is in the market, and the candle touches the stop-loss. So we want to get out because what we’re afraid of is the next bar; this will happen.
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There’s going to be a massive gap down, and if we don’t get out of trade, our stop-loss executed in the market, then this is what we’re going to suffer. So we’re going to have a massive loss.
That can happen, absolutely no question. But here’s what happens more often than not if you’ve got a stop-loss order placed in the market. You enter the trade on the candle; you place your stop-loss. Then the trade’s going along fine. When someone dumps a big sale order into the market, which causes a massive wick down. At the end of the day, the market closes way up here.
If you have a stop-loss in the market, this is where your order is going to get executed if you’re lucky. If you’re unlucky, it’s going to get executed down here some way because of slippage. So the chances are, you could get executed right at the low of the day with an in-market stop.
Instead of having an in-market stop-loss, you have the next buyer on an open stop or a chart-based stop. You have this line on your chart or the sell point in mind. If the trade, the stop touches this point during the day, then the next bar at the open here, you get out.
How does fear affect your trading?
It gives the market time for the fear to subside because the market is all about trading effectively in the markets. It’s all about managing anxiety and greed. The lower wick of your candle is the fear, and the upper wick is the greed. Often during the day, it’s the intraday fear when something terrible happens or when there’s a news announcement, or someone dumps a big sell order into the market.
The candle drops way down and touches people’s stop-loss, and gets you out. That fear is temporary. It subsides because the market is mean to reverting fear, greed, and emotion in the stock and crypto markets.
Extreme fear gives way to normality and greed. Greed gives way to normality and fear. And so, the volatility, up and down, is constant.
What happens if you’re placing stop-loss orders in the market?
If you’re placing your stop-loss orders in the market, then you are always getting executed at the point of maximum fear. That’s taking you out at the low end of the trade.
You need a stop-loss, no question. But if you place your stop-loss order in the market, placing your stop-loss order in the market will always get you out. Will always get you out at the point of maximum fear, and we don’t necessarily want to get out there. We want to get out at the point of maximum protection or profit. So if you’re trading on daily bars, letting that fear subside and getting out the next bar in the open gives the market a chance to normalize a little bit.
It’s true that sometimes if you don’t have your order in the market, instead of the market bouncing and you’re getting out here, it could get down, and you could get executed here instead of the next bar at the open, and have a bigger loss than what ideally you would like. But this is a numbers game, one of the things a lot of people miss about trading is it’s all about the numbers and the next thousand trades or the next hundred trades.
What you’re going to do instead of looking at this one trade and say, “Hey, I didn’t actually get my stop-loss, and then I got out the next bar on the open way down here. There’s one trade. It’s proof that it’s a bad idea.” That’s not true. That’s one data point. So instead, what you need to do is backtest your system with an in-market stop-loss and backtest your system with the next bar on open stop-loss and numerically, analytically compare the difference in profitability.
I’ve done this for all of my systems, and I’ve got a trading system in Hong Kong. It’s a momentum-based system. A next bar and open stop-loss give a 30% better expectancy than an in-market stop-loss with that system. 30% uplift in expectancy just by having the next bar on open stop instead of in-market.
I’ve got several crypto and cryptocurrency trading systems, and they all work dramatically better with the next bar on open stops. This is because the crypto markets are so volatile. These down weeks can be big, really vicious. However, if you give them a chance to calm down a little bit, the market often bounces back, and you can have them at a much better price. So next bar on open stops makes a huge difference.
If you also take this logic and flip it on its head, think about a profit target. Not all systems should have a profit target, but some profit targets work well. If you have a profit target, you want to maximize your chance of getting out at the proper target. The way you do that is you have an in-market profit target because at the point of maximum fear, maximum euphoria during the day, you want your profit targets to get executed. You don’t want to wait for the next bar to open because that greed will probably subside and revert to normal. So you’ll get out actually at a lower price.
So again, what you want to do is prove this through backtesting, and you want to backtest with a package like AmiBroker. It’s very easy to do. It’s just like a simple little, totally swick, flip, flick in the profit target or in the stop-loss to go for the next bar and open to in-market and back again.
You’ll see when you have a profit target that an in-market profit target is much more profitable, generally than an expired open profit target because you’re capitalizing on the greed that’s going on in the market. Just like with a stop-loss, you want the reverse going on. You don’t want to be impacted by the fear. You want to let the fear subside and then get out at a more normal price.
When you got a profit target, you want to capitalize on the greed, so you have an in-market profit target. But again, test this for yourself. If you’re not trading systematically, then these are the sorts of reasons. These are the sorts of things that you can do when you take that step to trade systematically. You can test and prove all of these things in data quickly and easily, not just by looking at one or two charts. When you’re backtesting this sort of concept in AmiBroker, it’s very easy to test over a few thousand stocks in the market, over 20 to 30 years of stock market history in almost the blink of an eye, a couple of seconds, and you’ll get the data to prove or disprove that hypothesis.
That’s how you become an Enlightened Stock Trader. That’s how you improve your profitability by testing these concepts that people have been scouting for years, but they’re just crap. Think about it.
Are you using in-market stop-losses? Then, it’s time to think about, “Should I maybe use the next bar on open stop-loss.” Are you using a profit target? It should probably be an in-market profit target. And either way, if you haven’t backtested your trading system, that’s your next step. If you need help with that, comment below, and I’ll give you some resources to help you point you in the right direction to improve your trading systematically by backtesting.